Bankruptcy and the Secured Creditor

In the last few years there have been a number of widely publicized
bankruptcies such as Eastern Airlines and Macy's. In North Carolina we
have seen Brendle's, Piece Goods and Roses Department Stores file for
bankruptcy protection. From 1984 to 1991, the bankruptcy filings
throughout North Carolina reflected a 40% increase. Of those filings,
approximately 25-30% were Chapter 7 liquidations, 70-75% were Chapter
13 wage-earner reorganizations, and the rest were either Chapter 11
reorganizations or Chapter 12 farmer reorganizations.

This manuscript will discuss the effect of bankruptcy on secured claims.

Addressed will be the impact of the automatic stay, the need for adequate
protection, the debtor's valuation of secured claims, the Chapter 11
confirmation process, the trustee's avoidance powers, the rights of lessors
and lessees, the debtor's use of cash collateral and the debtor's use, sale
or lease of property.

A. The Automatic Stay-The Mortgagor-Debtor's Shield.

1. The Block of the Automatic Stay.
Immediately upon the filing of a bankruptcy petition under Chapters 7, 11,
12, or 13, a creditor is prohibited or stayed from taking any action which
has the purpose and result of collecting a debt or taking possession of
property or assets of the debtor. 11 U.S.C. § 362(a). Section 362(a) sets
forth a list of activities which are subject to the automatic stay. These are:
· the commencement or continuation of legal proceedings against the
debtor to recover a claim that arose prior to the petition being filed;
· the enforcement of a prepetition judgment against the debtor or against
property of the bankruptcy estate;
· an act to obtain possession of, or exercise control over, property of the
estate;
· an act to create, perfect or enforce any lien against property of the
bankruptcy estate;
· an act to create, perfect or enforce any lien against property of the
debtor, any lien to the extent that such lien secures a prepetition claim;
· an act to collect, assess or recover a prepetition claim against the
debtor;
· the setoff of any debt owing to the debtor that arose before the
commencement of the case against any claim against the debtor; and
· the commencement or continuation of a proceeding before the United
States Tax Court concerning the debtor.
11 U.S.C. § 362(a).
Additionally, in Chapter 12 and 13 cases, creditors are prohibited from
attempting to collect consumer debts from co-debtors, unless the co-debtor
became liable for the debt in the ordinary course of the co-debtor's
business or until the case is closed, dismissed or converted to Chapter 7.
11 U.S.C. §§ 1201 and 1301.
The Bankruptcy Court has other ample powers to stay actions not covered
by the automatic stay. H.R. Rep. No. 95-595, 95th Cong., 1st Sess. (1977)
at p. 342 makes specific reference to 11 U.S.C. § 105(a)(1), 28 U.S.C. §
1481(2)and the All Writs Statute, 28 U.S.C. § 1651(3).

2. What is the Scope of Stay?

Although the automatic stay is broad and encompasses most collection
activities, certain exceptions exist. For example, the automatic stay is not
applicable to the following:
· post-petition transactions;
· the commencement or continuation of a criminal proceeding against the
debtor;
· the collection of alimony, maintenance, or support from property that is
not property of the estate (i.e., post-petition wages or income of the debtor);
· the commencement or continuation of an action or proceeding by a
governmental unit to enforce such governmental unit's police or regulatory
power; and
· any act to perfect an interest in the property to the extent that the
trustee's rights and powers are subject to such perfection under § 546(b) of
the Bankruptcy Code.

11 U.S.C. § 362(a) and (b).

The automatic stay is also inapplicable to separate legal entities such as
corporate affiliates, partners in debtor partnerships or to codefendants or
guarantors in pending litigation. 2 Collier on Bankruptcy ¶ 362.04 (15th ed.
1993); see also Patton V. Bearden, 8 F.3d 343 (6th Cir. 1993); In re Marley
Orchards Income Fund I, Limited Partnership, 120 B.R. 566 (Bankr. E.D.
Wash. 1990) (refused to extend automatic stay to general partners of a
debtor-partnership under § 362(a)(3) absent evidence of a potential
deficiency in partnership assets). However, some courts have extended the
automatic stay to non-bankrupt third parties in "unusual circumstances."
See A.H. Robins Co. V. Piccinin, 788 F.2d 994 (4th Cir. 1986), cert. denied,
479 U.S. 876 (1986);  In re Litchfield Co. of South Carolina Limited
Partnership, 135 B.R. 797 (W.D.N.C. 1992);  In re Kanawha Trace Dev.
Partners, 87 B.R. 892 (Bankr. E.D. Va. 1988).

With respect to acts against property of the estate, the automatic stay
continues until such property is no longer property of the estate (i.e. where
it has been abandoned under § 554(c)). 11 U.S.C. § 362(c)(1). With respect
to all other acts, the automatic stay continues until the earliest (i) the case
is closed; (ii) the case is dismissed; (iii) a discharge is granted or denied in
the case of an individual bankruptcy proceeding; (iv) a plan is confirmed in
a Chapter 11 case; or (v) the stay is terminated by order of the court, or by
inaction of the court upon request for leave from the stay. 11 U.S.C. §
362(c)(2).

What happens when a secured creditor has repossessed its collateral prior
to the filing of the Debtor's petition? This question was answered by the
Supreme Court in United States v. Whiting Pools, Inc., 462 U.S. 198, 103
S.Ct. 2309, 76 L.Ed.2d 515 (1983). In that case, the Internal Revenue
Service levied on and took possession of the debtor's property. On the
following day, the debtor filed a bankruptcy petition which stayed the
Internal Revenue Service from taking any further action against the
property. The Internal Revenue Service instituted an adversary proceeding
seeking a determination that the automatic stay provisions of Section 362
were not applicable to it or, in the alternative, requesting that the stay be
lifted to permit it to sell the property. The Internal Revenue Service argued
that "property of the estate" under § 541 of the Bankruptcy Code consists
only of the debtor's interest in property as of the time the bankruptcy
petition is filed. The Supreme Court, however, found that the debtor
retained an "equitable" interest in the property since it had not yet been
sold and thus ordered the Internal Revenue Service to return the property
to the debtor under § 542 of the Bankruptcy Code.
This same analysis has been used with regard to foreclosure proceedings;
if the sale has not been completed prior to the filing of the debtor's
bankruptcy petition, then the debtor may request turnover of the property.
The secured creditor faced with this situation should request adequate
protection of its security interest or, in the alternative, relief from the
automatic stay. According to Judge Small in the Eastern District of North
Carolina, if a bankruptcy petition is filed after the foreclosure sale but prior
to the expiration of the upset period, a Chapter 13 debtor is not entitled to
possession or "redemption" of the property unless the secured creditor
foreclosing on the property is paid in full. In re DiCello, 80 B.R. 769 (Bankr.
E.D.N.C. 1987).(4)

3. What are the Sanctions for Violating the Stay?

Generally, actions taken in violation of the automatic stay are void and
without effect. 2Collier on Bankruptcy, ¶ 362.11 (15th ed. 1993).
(5) Moreover, they could lead to serious consequences for the creditor. For

example, the trustee and/or debtor may seek to have the creditor found in
contempt and fined, enjoined under § 105 of the Bankruptcy Code from
further attempts to collect the debt, or sanctioned. If the trustee and/or
debtor is successful, the secured creditor may be assessed with costs and
attorney's fees. Section 362(h) of the Bankruptcy Code further provides
that an individual injured by a willful violation of the automatic stay may be
entitled to recover punitive damages in addition to actual damages which
include costs and attorney's fees.  See  In re Michael A. and Cynthia
Capehart, Case No. B-87-2663C-13 (Bankr. M.D. NC). Attorneys should be
mindful of the Fifth Circuit's decision in Pettitt v. Baker, 876 F.2d. 456 (5th
Cir. 1989) in which the bankruptcy court assessed both the creditor and the
creditor's law firm for a violation of the automatic stay.

Because of the Bankruptcy Court's desire to protect debtors upon the filing
of the bankruptcy petition, creditors should cease all collection or
enforcement activities immediately upon learning of the bankruptcy
filing.  See  In re Melvin Andrew Withrow, Case No. C-B-87-00861 (Bankr.
W.D.N.C.) Knowledge of the filing includes any verbal or written notice
received by the creditor or an agent of the creditor from the debtor, the
debtor's attorney, the court or any third party source.
4. Obtaining Relief from the Stay.
The automatic stay merely gives the debtor a "breathing spell" once a
bankruptcy petition is filed. Unless the stay is otherwise terminated, a
secured creditor can obtain permission from the Bankruptcy Court to lift the
automatic stay in order to foreclose its security interest in the collateral.

According to Bankruptcy Rule 4001, an action for relief from stay is a

contested matter under Bankruptcy Rule 9014. A motion is filed requesting
relief from the automatic stay with the court and the other party is afforded
reasonable notice and an opportunity for hearing. Rule 4001(a)(1), F.R.B.P.
The proper parties to a motion for relief from stay are the debtor, the
trustee, if one has been appointed, and the U. S. Bankruptcy
Administrator's office in a Chapter 11 case. Rule 4001(a)(1), F.R.B.P. Junior
lienholders and creditors' committees may intervene in the proceeding, but
are not necessary parties.

Within thirty (30) days after relief from the automatic stay is requested, the
stay will terminate unless the court orders the stay continued pending the
conclusion of a final hearing and determination on the request for relief. In
the Western District of North Carolina, the Local Rules provide that the
initial hearing on termination or modification of the stay will be a final
hearing unless one of the parties requests that the hearing be a preliminary
hearing.(6)

Relief from the automatic stay will be granted if the moving party can show
(i) cause, including the lack of adequate protection, or (ii) no equity in the
property and the property is not necessary to an effective reorganization. 11
U.S.C. § 362(b).

The party requesting the relief has the burden of proof on the issue of
whether the debtor has equity in the property and the party opposing the
relief (usually the debtor) has the burden of proof on all other issues,
including whether or not the property is necessary to an effective
reorganization.

Termination of the stay for "cause" is typically brought by a secured creditor

on the grounds that its interest in the collateral is not adequately protected.
Cause, however, can also include the lack of good faith in filing the
bankruptcy petition.  In re Victoring Construction Co., Inc., 9 B.R. 549
(Bankr. C.D. Cal. 1981).(7)

B. Adequate Protection-The Mortgagee's Sword.

Because the automatic stay prevents secured creditors from foreclosing on
their collateral, the Bankruptcy Code recognizes that creditors are entitled
during the pendency of a bankruptcy case to have the value of their
security interest protected against any decrease in value or depreciation.
Thus, a secured creditor has the right to adequate protection if a debtor
proposes to use, sell or lease property which constitutes the creditor's
collateral during the bankruptcy case or if the debtor proposes to secure
post-petition borrowing by granting an interest in the secured creditor's
collateral equal or senior to the security interest held by the creditor.

1. Illustrations of Adequate Protection Under the Bankruptcy Code.

The term "adequate protection" is not defined under the Bankruptcy Code.
As a result, this issue is frequently litigated by secured creditors who want
to protect their collateral during the pendency of the bankruptcy case.
Section 361 of the Bankruptcy Code offers little guidance. It suggests that
adequate protection may consist of:
i. Periodic Payments. Usually the payment is cash or a cash-equivalent.
The payment(s), however, may be less than the full principal and interest
required under the loan documents.
ii. Additional or Replacement Liens. Giving of an additional or replacement
lien to the extent necessary to compensate for a decrease in value of the
secured creditors' interest in property. If the debtor's property is fully
encumbered, the granting of an additional or replacement lien does not
constitute adequate protection.
iii. Indubitable Equivalent. This occurs when the creditor receives
something of value which will allow it to realize the "indubitable equivalent"
of its security interest. Courts sometimes find this form of adequate
protection to exist when the value of the collateral exceeds the debt owed
the secured creditor. The larger the excess value or "equity cushion," the
more likely a court is to find a secured creditor is adequately protected by
its current oversecured position. The Bankruptcy Code sets forth some
limits as to what satisfies the "indubitable equivalent" standard. Under 11
U.S.C. § 361(3), an administrative expense priority would not qualify.

2. What Interests are Entitled to Adequate Protection?

Adequate protection is not automatically provided to a secured creditor
under the Bankruptcy Code. Nor is it likely to be voluntarily offered by the
debtor. If it is, the timing, form or amount of the adequate protection may be
unacceptable. In order to protect its collateral, a secured creditor must be
prepared to pursue its rights in the Bankruptcy Court by filing of a motion
for relief from the automatic stay or, in the alternative, for adequate
protection. In a Chapter 11 case, the motion should be made early
especially if the property is deteriorating or depreciating in value.

Whether a secured creditor is entitled to adequate protection depends upon

whether the secured creditor is "oversecured" (the collateral is worth more
than the debt) or "undersecured" (the debt is greater than the collateral
value). In general, an oversecured creditor is entitled to adequate
protection of its claim. This adequate protection may be in the form of post-
petition interest on its claim. Adequate protection to an oversecured creditor
may also take into account payment of both principal and interest. An
undersecured creditor, however, is not entitled to adequate protection in the
form of post-petition interest. In order to receive adequate protection, an
undersecured creditor must demonstrate that its collateral is actually losing
value.

The concept of adequate protection is discussed at length by the Supreme

Court in the landmark decision of  United Savings Association of Texas v.
Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365, 108 S. Ct. 626,
98 L. Ed. 2d 740 (1988). In Timbers, the Supreme Court held that adequate
protection does not include payments to an undersecured creditor for "lost
opportunity cost" caused by the delay in foreclosing the collateral and
reinvesting the proceeds elsewhere. The facts in that case, however,
involved property which was appreciating. In subsequent cases, where the
property has been found to be depreciating, undersecured creditors have
been entitled to receive periodic payments.  In re Flagler-At-First Assoc.
Ltd., 114 B.Rl 297 (S.D.Fla. 1990).
One court has interpreted Timbers to mean that an oversecured creditor is
entitled to post-petition interest under § 506(b)  only  to the extent of the
oversecured creditor's equity cushion.  In re Westchase I Associates, L.P.,
126 B.R. 692 (W.D.N.C. 1991). Under this rationale, if a secured creditor is
only marginally oversecured,  Timbers  would not entitle the creditor to
adequate protection payments in order to preserve the slim equity
cushion. Id. at 694-695.

3. What Happens if Adequate Protection Turns Out to be Inadequate?

In the event adequate protection turns out to be inadequate, a secured
creditor should file or renew its motion for relief from stay, request
additional adequate protection in the form of periodic payments, or seek
additional or replacement liens. In addition, § 507(b) provides that a
secured creditor who is entitled to adequate protection has a first priority
claim to the extent that the protection has not been adequate. 11 U.S.C. §
507(b);  In re Clark at Center Leasing Co., Inc., 991 F.2d 682 (11th Cir.
1993) opinion amended on denial of rehearing by 4 F.3d 940 (11th Cir.
1993). This "super-priority" status allows an inadequately protected
secured creditor the right to be paid ahead of all other administrative
claims, subject to the super-priority status of any § 364(c)(1) post-petition
financing claim.

The extent to which a secured creditor is entitled to a § 507(b) claim is

discussed at length in In re Cheatham, 91 B.R. 382 (E.D.N.C. 1988). In that
case, the creditor had consensually agreed with the Debtor to adequate
protection payments which later turned out to be inadequate. The court
held that the creditor's super-priority claim would be limited to the extent of
adequate protection payments which were in default, plus any unexpected
diminution of value of collateral caused by unforeseeable circumstances
such as fire, flood or market collapse; it was not entitled to losses arising
from foreseeable circumstances such as normal depreciation or wear and
tear of collateral.

C. Valuation of Mortgagee's Claim.

Valuation of property is important in any bankruptcy case. It is necessary
to:
· decide whether a creditor is entitled to adequate protection of its
interest under §§ 361, 362, 363, 364 and 1205 of the Bankruptcy Code;
· decide whether the creditor is entitled to relief from the automatic stay
pursuant to § 362(d) of the Bankruptcy Code;
· decide whether the trustee of a bankrupt estate may sell property of the
estate pursuant to § 363(b) or (c) of the Bankruptcy Code;
· decide whether a plan should be confirmed pursuant to § 1129 of the
Bankruptcy Code;
· decide whether interest and attorneys' fees should be allowed pursuant
to § 506(b) of the Bankruptcy Code; and
· decide whether the full amount of claim is secured by the collateral
under § 506(a) of the Bankruptcy Code.
See  generally, Harden "Claims of Secured Creditors,"  Protection of
Secured Interests in bankruptcy in North Carolina, N.B.I. (1989).

1. Procedure for Valuing Secured Claims.

Bankruptcy Rule 3012 deals with the procedure in the valuation of a
secured claim. It provides that:
[t]he court may determine the value of a claim secured by a lien on property
in which the estate has an interest on motion of any party in interest and
after hearing on notice to the holder of the secured claim and any other
person as the court may direct.
Rule 3012, F.R.B.P. A valuation proceeding is a contested matter under
Bankruptcy Rule 9014. If the validity, priority or extent of a lien is at issue,
in addition to the valuation of the secured claim, Bankruptcy Rule 7001(2)
states that the proceeding is an adversary proceeding which is initiated by
the filing of a complaint. Typically at a valuation hearing, the parties will
present evidence of value, usually through testimony by appraisers or other
experts.

2. Determination of Secured Status - § 506(a).

Section 506(a) permits a debtor to bifurcate a secured claim into two parts
depending upon the value of the collateral. Under this analysis, a secured
creditor has an allowed secured claim to the extent of the value of its
collateral and an unsecured claim for any balance. 11 U.S.C. § 506(a). The
question in most bankruptcy cases is how to value the collateral.
There is little guidance in the Bankruptcy Code on how to value collateral.
Section 506(a) suggests that "value shall be determined in light of the
purposes of the valuation and proposed disposition or use of such property,
and in conjunction with any hearing on such disposition or use on a plan
affecting such creditor's interest." 11 U.S.C. § 506(a).

The value assigned to collateral will generally be different depending upon

whether the debtor proposes to dispose of the property or to retain it and
use it.  See,  In re Sprecher, 65 B.R. 598 (Bankr. C.D.Ill. 1986). Several
different standards have been developed by the courts for valuing property
depending on the reasons for valuation. These are:
· Fair Market Value: The fair market value of property is its value if it
were to be marketed in a commercially reasonable manner, defined as
what a willing buyer would pay a willing seller for the property.
· Going Concern Value:  The going concern value of the property is
appropriate when the debtor is attempting to retain the collateral and
continue the operation of its business.
· Forced Liquidation Value: The forced liquidation value of property is
ordinarily the lowest value, and it is the appropriate standard to use when,
for example, a business has ceased operations.
· Other Valuation Standards: These may include book value,
depreciation value, and replacement value.
The value of the collateral is generally determined as of the date for which
the valuation relates. 3 Collier on Bankruptcy, ¶ 506.04(2) at 35 (15th Ed.
1993). For example, the petition date is used when determining the amount
of a secured claim in a Chapter 7 case for purposes for distribution while
the effective date of the plan is used for determining the value of an
allowed secured claim in a Chapter 11 or 13 case. Reference as to what
dates are applicable should be made to the Bankruptcy Code, case law
and 3  Collier Bankruptcy Practice Guide, § 52.05 at 11-12 (1986) for
additional guidance. It should also be noted that the determination of value
of collateral at one point in the case is not be binding at another point in the
case. However, a secured creditor should be careful if it attempts to
establish a low value for its collateral on a motion for relief from stay and
then seeks to have a higher value for plan purposes or to obtain
reimbursement of § 506(b) attorney's fees and costs.
Secured creditors should also look at the present and prospective value of
their collateral. Present value determines whether there is "equity" in the
property and prospective value determines whether the property is
necessary for an effective reorganization. 11 U.S.C. § 362(d)(2).

(a) Determining Present Value.

In determining the present value of income-producing real estate, most
appraisers use three methods:
i. Replacement Cost. Under this approach, the appraiser will estimate
the cost of new improvements, deduct depreciation, and add the value of
the "dirt." The older the property, the less reliable this approach is.
ii. Comparable Sales or "Market Data" Approach. An appraiser
identifies recent sales of property which are "comparable" to the existing
property. Adjustments are then made to each of the "comparables" to
reflect differences such as location, size, visibility and age between the
subject property and each "comparable." The appraiser will then average
the "comparables" to develop a factor that can be applied to the subject
property.
iii. Discounted Income or Discounted Cash Flow Approach. Under
this approach, the net income generated by the property, before debt
service is estimated, vacancy and other operating expenses are deducted
and a capitalization rate is applied. This analysis can be skewed by such
key variables as occupancy levels or vacancy rates, rents per square foot
and operating expenses.
(b) Determining Prospective Value.
The method used for determining prospective value for an income-
producing property is, in effect, the reverse of the "discounted cash flow"
approach to present value. To determine prospective value using this
approach, annual net operating income is estimated over the life of a
hypothetical plan. As in the case of discounted cash flow, assumptions are
made as to rental rates, occupancy levels and expenses. This analysis
focuses on the determination of net income for the last year of the holding.
Once that figure is determined, a capitalization rate is identified for that
year and applied to the net income figure to determine the estimated value
for the last year of the plan. After the capacity of the property to generate
cash over time is estimated, this capacity is compared with the payments
required under a hypothetical plan to determine whether the debtor is
capable of an effective reorganization.
3. Lien Avoidance - § 506(d).
Section 506(d) provides for the avoidance of any lien securing a claim
which is not allowed except under the following explicitly enumerated
circumstances: if the claim was disallowed because it had not yet matured
or was for reimbursement or contribution, or because the creditor failed to
file a proof of claim.

The relationship between the lien avoidance provisions of § 506(d) and the
bifurcation provision under § 506(a) discussed above has given rise to a
number of conflicting court decisions. Some courts have held that a lien
can be "stripped" down to the value of the collateral pursuant to the
bifurcation provisions under § 506(a). See Gaglia v. First Federal Savings &
Loan Assoc., 889 F.2d 1304 (3d Cir. 1989);  In re Jablonski, 88 B.R. 652,
658 (E.D. Pa. 1988). Other courts have held that a lien securing a claim
could be avoided pursuant to § 506(d) only if, and to the extent that, the
lien was disallowed.  In re Dewsnup, 908 F.2d 588 (10th Cir.
1990), aff'd, Dewsnup v. Timm, 502 U.S. ____, 112 S.Ct. 773, 116 L.Ed.2d
903 (1992).

In an effort to resolve the existing split between the circuits, the Supreme
Court inDewsnup v. Timm, supra, held that § 506(d) does not permit a lien
to be "stripped down" to the value of the collateral determined in
accordance with § 506(a). The court noted that even though the term
"allowed secured claim" might arguably have the same meaning for
purposes of § 506(d) that it does for § 506(a), Congress did not intend to
depart from the pre-Bankruptcy Code rule that liens pass through the case
unaffected. Thus, § 506(d) can be used to avoid a lien only if the underlying
claim is disallowed, not if a portion of the claim is deemed unsecured by
operation of § 506(a). Dewsnup v. Timm, supra.

Because  Dewsnup  involved a Chapter 7 case, there was some dispute

whether this holding also applied in Chapter 13 cases. Section 1322, which
is applicable only in Chapter 13 cases, specifically provides that a Chapter
13 plan may modify the rights of secured creditors with one exception. This
exception applies to secured creditors who have a security interest in real
property which serves as a principal residence of the debtor. 11 U.S.C. §
1322(b)(2).
The apparent conflict between § 506(a) and § 1322(b)(2) was recently
settled by the Supreme Court in  Nobleman v. American Savings Bank,
_____ U.S. _____ 113 S.Ct. 2106, 124 L.Ed.2d 228 (1993).
The Nobleman court rejected the holdings of four Courts of Appeals, which
had held that § 1322(b)(2) prohibited only modification of the claim holder's
rights with respect to the secured portion of its claim. Instead, the court
determined that § 1322(b)(2) prohibits a debtor's plan from providing that
the unsecured portion of a claim that has been bifurcated under § 506(a)
could be treated the same as other unsecured claims since a plan which
provides that a secured claim which is not being paid in full would thereby
modify the rights of the holder of the claim.

It is important to note that neither the prohibition of modification in §

1322(b)(2) nor theNobleman  decision which interprets this section is
applicable to Chapter 13 creditors who have a security interest in property
other than the debtor's principal residence. 5Collier on Bankruptcy, ¶
1322.06. Thus, a claim secured by any other real property or by personal
property of the estate may be modified by the Chapter 13 plan.(8)

4. Allowance of § 506(b) Interest, Fees and Expenses.

To the extent of any surplus value in the collateral, the secured creditor is
entitled to interest and reimbursement of attorneys' fees and expenses. 11
U.S.C. § 506(b).

The right to interest apparently exists whether or not the documentation so

provides. In re Best Repair Co., Inc., 789 F.2d 1080 (4th Cir. 1986). In the
case of attorneys' fees, state law controls although the court will review the
attorneys' fees for reasonableness.See  Matter of Scarboro, 13 B.R. 439
(D.C.Ga. 1981).

Judge Tart recently denied an oversecured creditor reimbursement of its

attorneys' fees under § 506(b) for its post-confirmation services rendered in
drafting loan modification documents.  In re Gwyn, 150 B.R. 150 (Bankr.
M.D.N.C. 1993). In its decision, the court set forth the following test for
determining whether § 506(b) fees should be allowed: whether the services
rendered were within the scope of the terms and provisions of a legal
document and whether they were reasonable and necessary for collection
of the amounts owed by the debtor. Under this analysis, the court declined
in the Gwyn case to conclude that a contract clause for attorneys' fees for
collection efforts should be broadly read to include all services rendered in
connection with the debtor. The court found that the vast majority of the
services rendered during the period of time covered by the fee application
were not necessary for the collection of the amounts owed to the secured
creditor.

D. How to Handle the Confirmation Process of Chapter 11 Plans.

1. Affect on Liens.
The general rule in bankruptcy is that valid liens that have not been
disallowed or voided pass through bankruptcy unaffected.  See  FDIC v.
Davis, 733 F.2d 1083 (4th Cir. 1984). Secured creditors, however, should
carefully review the debtor's proposed plan to see if its security interest is
altered. Section 1141(c) provides that after confirmation, except as
provided in the plan or in the order confirming the plan, the property dealt
with by the plan is free and clear of all liens and interest of creditors of the
debtor. If the plan fails to provide for continuation of the security interest
after confirmation, a secured creditor's rights can be extinguished.  See  In
re Nardulli & Sons Co., Inc., 66 B.R. 871 (Bankr. W.D. Pa. 1986);  In re
Arctic Enterprises, Inc., 68 B.R. 71 (D. Minn. 1986).

2. Confirmation Process.
In order for a Chapter 11 plan to be confirmed, all of the requirements
under §1129(a) must be satisfied. Included among these requirements are
that the plan comply with bankruptcy law, be proposed in good faith and not
by illegal means, disclose certain parties, payments and services in
connection with the plan in Chapter 11 case, provide proper treatment for
priority and retiree benefit claims and be accepted by at least one
"impaired" class of claims.
Section 1129(a) further requires that the plan satisfy the "best interests of
creditors" test. This test requires that as of the "effective date" of the plan,
each creditor must receive payments or other property totaling not less
than what it would receive in a Chapter 7 liquidation. In a partnership case,
a liquidation analysis includes not only the assets of the partnership, but
also the net assets of the general partner. Note that § 1129(a)(7)(B)
excepts secured creditors who have made a § 1111(b)(2) election, which is
discussed in section D(2)(c) below, from application of the "best interests of
creditors" test.

Finally, § 1129(a)(11) requires the court to find that the plan is feasible and
is not likely to be followed by liquidation or the need for further
reorganization of the debtor. 11 U.S.C. § 1129(a)(11). Factors in
determining feasibility include adequacy of capital structure, earning power
of the business, economic conditions, ability of management, availability of
credit and provisions for adequate working capital.  In re Guilford
Telecasters, Inc., 128 B.R. 622 (Bankr. M.D.N.C. 1991).

3. Other Considerations.
(a) Impairment of Secured Claims.
Impairment determines whether a class is required to vote for or against a
proposed plan. A class which is not impaired is deemed to have accepted
the plan and a formal vote is not required. If a class is impaired, the class
must vote to accept the plan or the proponent must resort to the "cram
down" provisions under § 1129(b) which are discussed below.
According to § 1124, a class of claims is not impaired if the plan -
(i) leaves unaltered the legal, equitable and contractual rights of a claimant;
(ii) cures a default;
(iii) reinstates maturity of a claim to its pre-default status; and
(iv) compensates claimants for damages incurred to their reasonable
reliance on particular contractual provision or applicable law.

11 U.S.C. § 1124.  See  also  In re Gillete Associates, Ltd., 101 B.R. 866
(Bankr. N.D. Ohio 1989). A secured claim that is in default will be
considered "impaired" unless the plan proposes to (i) reinstate the debt on
the conditions prescribed by 11 U.S.C. § 1124(2) referred to above, or (ii)
"buy out" the secured creditor. If the plan proposes to "buy out" the secured
creditor, the debtor must pay cash on the effective date of the plan equal to
the allowed amount of the secured claim. 11 U.S.C. § 1124(3). Payment of
stock or other consideration that is not cash, even if this consideration is
worth more, will not trigger this provision and the secured creditor will be
deemed impaired.

If the Plan does not propose to leave unaltered the rights of the secured
creditor, to restore the creditor to its original position by curing the default,
or "buy out" the claim under 11 U.S.C. § 1124(3), the secured claim is
considered impaired. Thus, any attempt by the debtor to modify the terms
of the loan documents (i.e. change the maturity date of the loan or interest
rate), the security agreement or any third party agreement or guaranty, or
bifurcate the claim under § 506(a) constitutes impairment of a secured
creditor's claim.

(b) Classification of Secured and Deficiency Claims.

Claims and interests of creditors are classified in Chapter 11 plans for
purposes of treatment. 11 U.S.C. § 1123(a)(1). A plan may place a claim or
interest in a particular class only if such claim or interest is substantially
similar to the other claims or interests in that class.

11 U.S.C. §1122(a). Secured creditors are usually placed in separate

classes with the proposed treatment in each class tailored to meet that
creditor's particular loan and collateral. If a secured creditor is
undersecured, the debtor will often classify the secured portion of the claim
in one class and classify the deficiency claim in another class. This dual
classification poses problems in a single asset real estate cases since
there is generally a primary secured creditor and several smaller trade
creditors. By classifying the deficiency claim, which is usually large, with
other unsecured claims, the undersecured creditor can affect the
acceptance or rejection of the debtor's plan by that class.(9) Faced with this
prospect, the debtor is forced to meet the demands of the undersecured
creditor regarding treatment of the its claim or risk having the court deny
confirmation of its plan.

To circumvent this problem, debtors have attempted to classify deficiency

claims differently from the other unsecured creditors in order to achieve an
affirmative vote on their reorganization plans. Such attempts have been
struck down by some courts.  SeeIn re Bryson Properties XVIII, 961 F.2d
496 (4th Cir. 1992);  Greystone III Joint Venture, 948 F.2d 134 (5th Cir.
1991) (as amended). However, other courts have allowed this separate
classification so long as the debtor can establish a basis under 11 U.S.C. §
1122 or an articulated business purpose. In re SM 104 Ltd., 160 B.R. 202
(Bankr. S.D.Fla. 1993).
(c) Section 1111(b) Election.
Sections 1111(b) and § 1129(a)(7)(B) of the Bankruptcy Code provide
secured creditors with special rights regarding treatment of their claims
under a plan.
(i)  Treatment of non-recourse debt - § 1111(b). Under § 1111(b)(1), a
secured creditor with a non-recourse loan will be allowed a unsecured
claim for any deficiency as if the creditor had personal recourse unless the
collateral is sold during the reorganization process or is to be sold under
the plan or unless the secured creditor makes an "election" under §1111(b)
(2) to have its entire claim treated as secured.
(ii)  Unsecured Creditor - §1111(b)(2).  Section 1111(b)(2) permits an
undersecured creditor (either recourse or non-recourse) with a lien of real
or personal property to elect to have an allowed secured non-recourse
claim equal to the total amount of its claim. This Section contradicts and
overrides § 506(a) which permits a debtor to bifurcate the claim of an
undersecured creditor into a secured claim equal to the value of the
collateral and an unsecured claim for any deficiency. In order to be eligible
for the § 1111(b)(2) election, the creditor:
(i) must have a claim which is secured by a lien on the debtor's property
(real or personal);
(ii) demonstrate that its interest in the property is not of inconsequential
value; and
(iii) show that it does not have recourse against the debtor if the property is
being sold under § 363 or is to be sold under the plan. 11 U.S.C. §1111(b)
(1)(B).
If a § 1111(b)(2) election is made, the secured creditor is entitled to receive
the total amount of its claim with payments having a present value equal to
the value of its collateral.
A secured creditor should consider exercising a § 1111(b)(2) election if it
believes that the collateral has been undervalued, the treatment accorded
unsecured creditors is unattractive, the debtor has no free assets, the
collateral will likely appreciate after the plan is confirmed, the plan will fail
and the debtor will be liquidated, or the debtor will likely sell the collateral
before the secured creditor is paid the present value of its interest in the
collateral. A secured creditor should not make a § 1111(b)(2) election,
except perhaps to defeat confirmation of a plan, if the present value to be
received on both its secured and unsecured claim is greater than the
payments it would receive under the § 1111(b)(2) election.
In order to make a § 1111(b)(2) election, Bankruptcy Rule 3014 requires
that the election be made at any time prior to the conclusion of a hearing on
the disclosure statement or within such later time as the court may fix. The
election must be made in writing and signed unless made at the hearing on
the disclosure statement. Once the election is made, a creditor cannot
withdraw the election unless the plan under which the election was made
either fails or is materially modified by the debtor. In re Keller, 47 B.R. 725
(Bankr. N.D. Iowa 1985).
Example of § 1111(b) Analysis: Suppose a creditor has a claim for
$100,000, but the value of the collateral is only $70,000. Under § 506(a),
the secured creditor would have a secured claim for $70,000 and an
unsecured claim for $30,000. In order to "cram down" the plan on the
secured creditor, the debtor would only have to pay the secured creditor the
present value of $70,000. Now suppose that the debtor proposes in its plan
to pay the present value of the secured claim ($70,000) at the rate of 8%
per annum in five (5) equal annual installments of principal and interest of
$17,532.20. Unsecured creditors are to receive a 5% dividend thirty (30)
days after confirmation.

Under the plan, the secured creditor will receive:

($70,000.00) Secured claim: $17,532.20 x 5 = $87,661.00
($30,000.00) Unsecured claim: $30,000.00 x .05 =$ 1,500.00
$89,161.00

If the secured creditor makes an § 1111(b)(2) election, its secured claim

would be $100,000 and the plan would no longer be fair and equitable
since the total deferred payments in the sum of $89,661 do not equal the
allowed amount of the secured claim. In order for the debtor to "cram
down" the plan on the secured creditor, who has now made the §1111(b)(2)
election, the debtor must propose a payment schedule that totals at least
$100,000 and which has a present value of $70,000 (the value of the
collateral). The debtor could thus modify the plan to pay the secured
creditor the sum of $70,000 with interest at the rate of 8% per annum in
nine (9) equal annual installments of $11,205.60. Under this equation, the
secured creditor would receive:
($100,000.00) Secured claim: $11,205.60 x 9 = $100,850.40
4. Cram Down.
If all of the general requirements of confirmation under § 1129(a) are met,
the plan may nevertheless be confirmed over the objection of a dissenting
impaired class under § 1129(b). In order to "cram down" a plan, the court
must find that (i) the plan does not discriminate unfairly; and (ii) the plan is
fair and equitable with respect to the impaired class which has not
accepted the plan. 11 U.S.C. § 1129(b).

The doctrine of unfair discrimination requires that a dissenting claim be

treated in a manner consistent with the treatment afforded to other classes
with similar claims against the debtor. To determine if there is unfair
discrimination, the court looks at the particular treatment and decides
whether the treatment is discriminatory, has a reasonable basis, is
proposed in good faith, and whether the plan is feasible without such
treatment.  In re Pine Lake Village Apartment Co., 16 B.R. 750 (Bankr.
S.D.N.Y. 1982). Discriminatory treatment with regard to secured claims can
occur when a senior secured claim is impaired while a junior lien claim is
unimpaired. Matter of Sandy Ridge Development Corp., 881 F.2d 1346 (5th
Cir. 1989). It can also occur when a deficiency claim is treated less
favorably than other unsecured claims. Greystone III Joint Venture,supra.

If the plan satisfies the prohibition against discrimination, the court then
determines whether the treatment to the dissenting class is fair and
equitable. With respect to secured claims, § 1129(b)(2)(A) provides that the
secured creditor must:
(i) retain its lien and receive cash payments which total at least the allowed
amount of its secured claim and which has a present value equal to the
value of its collateral; or
(ii) retain its lien on any proceeds if the collateral is sold free and clear of
the secured lien; or
(iii) realize the "indubitable equivalent" of its claim. Substitution of collateral
and abandonment of collateral by the debtor to the creditor have been held
to satisfy this requirement.  See  Matter of Sandy Ridge Development
Corp., supra; In re W. B. Simons, 113 B.R. 942 (Bankr. W.D. Tx 1990); In re
FCX, Inc., 853 F.2d 1149 (4th Cir. 1988).
5. Objections to Confirmation.
Following approval of the disclosure statement and prior to the confirmation
hearing, a secured creditor who objects to the treatment of its claim should
file an objection to confirmation with the court prior to the time fixed and, in
addition, should vote to reject the plan. Grounds for objection should track
the confirmation requirements under § 1129 of the Bankruptcy Code. In
addition, the secured creditor should consider filing motions for dismissal or
conversion and for relief from stay, if not previously filed.

Secured creditors should be particularly wary of plans in which the debtor

attempts to undervalue the secured creditor's collateral during the
reorganization, limit the secured creditor's claims to the collateral value and
sell the collateral either as part of the plan or after confirmation to another
third party. Such attempts undermine the secured creditor's § 1111(b) rights
since the secured creditor is not being allowed to retain the full value of its
claim. It also prevents the secured creditor in the event of a sale from
participating by allowing it to bid in its claim.

Finally, secured creditors should be careful of plans in which the debtor

attempts to release or avoid third party guarantees. Because these third
parties and their property are not subject to the bankruptcy courts
jurisdiction, these provisions are generally not allowed. However, if the
secured party fails to object, such provisions may be enforceable.

E. Avoiding the Mortgage - the Powers of the Trustee.

Under § 544 of the Bankruptcy Code, a bankruptcy trustee or debtor-in-
possession in a Chapter 11 case has certain "strong arm" powers under
which liens and/or transactions which otherwise would have been
considered valid had a bankruptcy petition not been filed can be voided.
1. Trustee as Hypothetical Lien Creditor - § 544(a)(1).
As a hypothetical lien creditor, the trustee has the right to avoid any transfer
of the debtor's property or any obligation incurred by the debtor that would
be voidable by a creditor who has extended credit and obtained a judicial
lien on all of the debtor's property. For example, the trustee as a
hypothetical lien creditor may defeat a security interest which is
unperfected as of the day of the bankruptcy filing. If a UCC-1 financing
statement has not been filed, was improperly filed or has lapsed, the
trustee can avoid a security interest and reduce the creditor to unsecured
status.
2.  Trustee as Hypothetical Bona Fide Purchaser of Real Estate - §
544(a)(3).
Because there is a significant difference between mortgages on real estate
and security interests in personal property, the Bankruptcy Code gives the
trustee the specific powers of a bona fide purchaser of real estate in
addition to its powers as a hypothetical lien creditor. Nevertheless, the goal
is the same - for the trustee to be able to defeat unrecorded or improperly
recorded real estate mortgages.
Under § 544(a)(3) and the North Carolina deed recording statute, a
bankruptcy trustee has priority over parties with interest in real estate
outside the chain of title. Daniel Flebotte v. John A. Northern, Trustee and
Allstate Ent. Mart. Co. (In re Fletcher Woods, Inc., Debtor), 887 F.2d. 1079
(4th Cir. 1989) (unpublished). However, in Angeles Real Estate Company v.
Kerxton, 737 F.2d 416 (4th Cir. 1984), the Fourth Circuit recognized that an
equitable lien was superior to the trustee's rights under § 544(a). Also in In
re Hartman Paving, Inc., 745 F.2d 307 (4th Cir. 1984), the court held that
Chapter 11 debtor-in-possession could not assert the rights of a
hypothetical bona fide purchaser for value to avoid an improperly
acknowledged deed when the debtor-in-possession had previously
acknowledged the defect. But cf., In re Sandy Ridge Oil Co., 807 F.2d 1332
(7th Cir. 1986).
3. Trustee as Successor to Actual Creditors - § 544(b).
As the representative of general creditors, the trustee or debtor-in-
possession may avoid any transfer that is "avoidable under applicable law
by a creditor holding an unsecured claim that is allowable." 11 U.S.C.
§544(b). Consequently, this power has been used effectively to reverse
bulk transfers that did not satisfy the requirements of the Bulk Sales Act
and to avoid certain transfers as fraudulent that were made more than one
(1) year prior to the filing of the bankruptcy and which otherwise could not
have been attacked under the Bankruptcy Code.(10)
In order to bring an action to avoid a mortgage under § 544, the trustee or
debtor-in-possession must file an adversary proceeding under Bankruptcy
Rule 7001 within the earlier of two (2) years after the appointment of a
trustee or the time the case is closed or dismissed. 11 U.S.C. § 546(a).
F. The Right of Lessors and Lessees.
Section 365 of the Bankruptcy Code provides that a bankruptcy trustee or
debtor-in-possession, subject to court approval, may under certain
conditions assume or reject an executory contract or unexpired lease. If the
bankruptcy trustee or debtor assumes the lease, all arrearage must be
cured and adequate assurance of future performance must be provided. 11
U.S.C. § 365((b). If a lease is rejected, the creditor has pre-petition claim
for damages which is limited under § 502(b)(6) to the past due rent plus the
rent reserved by the lease for the greater of one (1) year or fifteen percent
(15%) of the remaining term of the lease, not to exceed three (3)
years.  See  In re Bus Stop, Inc., 3 B.R. 26 (Bankr. S.D. Fla. 1980) (lessor
bound by limitations of § 502(b)(6) notwithstanding that the lessor obtained
a pre-petition judgment for the full amount of rents due).

In a Chapter 7 case, a trustee must assume or reject an executory contract

or unexpired lease of residential real property or personal property within
sixty (60) days after the order for relief or within such additional time as the
court, for cause, may fix, otherwise, such contract or lease is deemed
rejected. 11 U.S.C. § 365(d)(1). In a case under Chapter 11, 12 or 13, the
trustee may assume or reject an executory contract or unexpired lease of
residential real property or of personal property at any time prior to
confirmation of a plan. 11 U.S.C. § 365(d)(2). If a non-residential real
property lease is involved and the debtor is the lessee, then the trustee
must assume or reject the lease within sixty (60) days after the date of the
order for relief, or within such additional time as the court, for cause, shall
fix, otherwise such lease shall be deemed rejected. 11 U.S.C. § 365(d)(4).

If a secured creditor does not feel that it is being adequately protected prior
to the time its lease is assumed or rejected (i.e. it is not receiving rents or
does not have a sufficient security deposit), it can request that the court
enter an order fixing a time for the trustee or debtor-in-possession to
assume or reject the executory contract or unexpired lease.

G. Use of Cash Collateral.

"Cash collateral" includes a security interest in the debtor's cash,
negotiable instruments, documents of title, securities, deposit accounts and
other cash equivalents. 11 U.S.C. § 363(a).
Cash collateral also includes in the case of secured creditors proceeds,
rents and profits received by the debtor after commencement of the
bankruptcy case. Not included as "cash collateral" are proceeds in which
the underlying lien is unperfected or invalid or tenant deposits.

In order for the debtor to use cash collateral, the debtor must either obtain
the consent of the secured creditor or petition the court for an order,
following notice and hearing, to use the cash collateral.

In determining whether the debtor will be allowed to use cash collateral, the
court must find under § 363(e) that the secured creditor is adequately
protected. Unfortunately subsection (e) provides little guidance to assist in
this determination leaving the courts to struggle with this issue. Some
courts have found that a higher standard of adequate protection is required
before cash collateral may be used then that required for a motion for relief
from the automatic stay under § 362.  In re Berens, 41 B.R. 524 (Bankr.
D.Minn. 1984); Matter of Mickler, 9 B.R. 121 (Bankr. M.D.Fla. 1981). Other
courts have decided that the standard is the same. In re Marine Optical, 10
B.R. 893 (Bankr. App. 1 (Mass.) 1981); In re C.F. Simonin's Sons, Inc., 28
B.R. 707 (Bankr. E.D.N.C. 1983).

In deciding whether to allow the debtor to use cash collateral, the court
must balance the "irreconcilable and conflicting interests" of the debtor and
secured creditor. In re Stein, 19 B.R. 458 (Bankr. E.D.Pa. 1982). Often the
debtor is in need of cash to meet payroll, pay suppliers or to maintain the
property by providing utility, water and telephone service.

Faced with this problem, the courts have generally fashioned a remedy
whereby the debtor can continue to use cash collateral to preserve and
maintain the property. Such use may be conditioned upon regular reports,
periodic payments to the secured creditor, limitations or controls on the use
of cash collateral, additional replacement liens and, if necessary, the
appointment of an examiner or trustee.

Section 363(c)(3) sets forth the notice and hearing requirements regarding
the debtor's use of cash collateral as follows:
Any hearing under paragraph (2)(B) of this subsection may be a preliminary
hearing or may be consolidated with a hearing under subsection (C) of this
section, which shall be scheduled in accordance with the needs of the
debtor. If the hearing under paragraph (2)(B) of this subsection is a
preliminary hearing, the court may authorize such use, sale or lease only if
there is a reasonable likelihood that the trustee will prevail at the final
hearing under subsection (e) of this section. The court shall act promptly on
any requests for authorization under paragraph (2)(B) of this subsection.

Bankruptcy Rule 4001(b) further addresses the procedural requirements

which must be met prior to the debtor using cash collateral. Under this rule,
a motion for authorization to use cash collateral shall be made in
accordance with Rule 9014 and shall be served on any entity which has an
interest in the cash collateral, on any committee appointed under the Code
or on such other entities as the court may direct.

The court may commence a final hearing on a motion for authorization to

use cash collateral no earlier than fifteen (15) days after service of the
motion. If the motion so requests, the court may conduct a preliminary
hearing before such fifteen (15) day period expires, but the court may
authorize the use of only that amount of cash collateral as is necessary to
avoid "immediate and irreparable harm" to the estate pending a final
hearing.

The existence of "immediate and irreparable harm" has been used by some
bankruptcy courts in North Carolina to permit emergency cash collateral
orders to be entered on anex parte basis. In most cases, these emergency
orders are entered after notice to the secured creditor or with the secured
creditor's consent.

A preliminary hearing will then be immediately scheduled with notice of the

hearing generally given to the debtor, the debtor's attorney, the trustee, if
appointed, the United States Bankruptcy Administrator, any secured
creditors whose interests may be affected, the Internal Revenue Service
and the twenty (20) largest unsecured creditors (if a creditors' committee
has not yet been appointed).
At the preliminary hearing, the order is scrutinized by the court and the
other parties to determine whether the secured creditor is adequately
protected and/or whether the debtor took a "dive" by cross-collateralizing
pre-petition and post-petition assets or waiving the right to contest the
validity of the secured creditor's lien.

In the absence of either consent by the secured creditor or court approval

to use the cash collateral, the debtor is required under § 363(c)(4) to
segregate and account for any cash collateral in its possession, custody or
control.

In the event that the debtor fails to obtain authorization to use, sell or lease
collateral without prior consent or court approval or to segregate cash
collateral, the secured creditor may:
· Seek injunctive relief under § 105;
· Request the appointment of an examiner or a trustee under § 1104;
· Move for conversion or dismissal of the case under 1112;
· Move for relief from the automatic stay under § 362(b)(1);
· Seek an order conditioning the use of cash collateral or property under
§ 363(c) or denying such use under § 363(c)(2)(B);
· Move for retroactive adequate protection;
· Request an order modifying the Debtor's ability to operate under
Chapter 11 under §§ 1107 and 1108; and
· Request sanctions against both the debtor and the debtor's attorney.

1. Assignment of Rents.
Usually a secured creditor receives a security interest in rents and profits
either through a provision in a deed of trust or through a separate
assignment of rents. Sometimes the assignment is "absolute" i.e. the right
to receive rents and profits automatically; other times, the assignment does
not take effect until there is some type of default by the debtor, such as
nonpayment of the mortgage.

In 1991, the North Carolina Legislature amended N.C. Gen. Stat. § 47-20
governing the perfection of security interest in rents by recordation. This
legislation was in reaction to several confusing and controversial
bankruptcy court decisions in both the Western and Eastern Districts of
North Carolina. In In re Westchase I Associates, L.P., 119 B.R 521 (Bankr.
W.D.N.C. 1990), remanded 126 B.R. 692 (W.D.N.C. 1991) and In re Forest
Ridge II, Limited Partnership, 116 B.R.937 (Bankr. W.D.N.C. 1990), Judge
Marvin Wooten of the United States Bankruptcy Court for the Western
District of North Carolina held that notwithstanding the existence of an
assignment of rents provision, a secured creditor did not have perfected
security interest in post-petition rents and profits unless the secured
creditor had taken actual possession or constructive possession, such as
the appointment of a receiver of the real property. In contrast, Judge Small
in In re Raleigh/Spring Forest Apartments Associates, 118 B.R. 42 (Bankr.
E.D.N.C. 1990), differentiated between  perfection  of a security interest in
rents and profits andenforcement of a security interest in rents and profits.
Judge Small concluded that a creditor need only record its assignment in
order to be perfected therein. Id. at 45. However, Judge Small pointed out
that perfection does not mean enforcement. Since the creditor had not
taken steps to enforce the security interest in the rents at the time the
petition was filed, Judge Small allowed the debtor to use the post-petition
rents to maintain the property and to pay reasonable post-petition
administrative expenses with any rents above those required to maintain
the property sequestered for the benefit of the secured creditor. Id.

New N.C. Gen. Stat. § 47-20, which became effective on October 1, 1991,
provides, in pertinent part, that:
(i) recordation of an assignment of rents in the county registry where the
property is located perfects the assignee's interest in writs from the time of
recordation;
(ii) the assignment of rents may be a separate instrument or be a part of
another instrument such as a deed of trust; and
(iii) the assignee's entitlement is not contingent upon the appointment of a
receiver or the taking of possession of the property.
This legislation also defines a "collateral assignment" as an assignment to
convey an interest in rents as additional security, from a mere "assignment
of leases, rents, issues or profits" which is a cash-all definition applied to
any assignment. It further defines "rents, issues or profits" to include rents
paid under the terms of a conventional lease, as well as hotel receipts.
Generally, however, hotel receipts are personal property in the nature of
accounts receivables which must be perfected by filing a financing
statement in accordance with Article 9 of the UCC. See N.C. Gen. Stat. §
25-9-106; In re Ashoka Enterprises, Inc., 125 B.R. 845; In re Shore Haven
Motor Inn, Inc., 124 B.R. 617, (Bankr. S.D. Fla. 1991);  In re Oceanview/
Virginia Beach Real Estate Associates, 116 B.R. 57 (Bankr. E.D. Va. 1990).

2. Ousting and Jousting with a State Court-Appointed Receiver.

Assuming that the borrower is not in bankruptcy, a secured creditor will
generally request the appointment of a state-court receiver following default
in order to seize control of the property's rents. N.C. Gen. Stat. § 1-502.

Since the appointment of a receiver is an ancillary remedy, the request for

the appointment is usually made contemporaneously with the filing of a
foreclosure action. If it appears that the rents may be dissipated or
otherwise squandered by the debtor unless immediate action is taken, a
state court judge will appoint a temporary receiver without notice to the
debtor. A show cause order is then issued and the debtor is notified of a
hearing to determine whether the temporary receiver should be made
permanent. N.C. Gen. Stat. § 1-502.

A receiver under North Carolina law is given specific powers by statute and
case law so that he may properly control, preserve and settle the property
and assets, including rents, of the insolvent debtor. See N.C. Gen. Stat. §
1-507.3.

In the event that the borrower-debtor files a bankruptcy petition following

the appointment of a receiver, a secured creditor may file a motion to
continue the receivership pursuant to 11 U.S.C. §§ 105 or 543. Because
the Bankruptcy Code overrides and supersedes state law legislation
governing receiverships, this motion may not be successful unless the
conditions set forth in § 543(d)(1) or (2) can be shown. I

f the motion for a receiver is denied, the secured creditor should then either
seek the appointment of a trustee or, as a condition to the entry of cash
collateral order, demand that the receiver be appointed as "property
manager" to operate the property and receive rent. It should be noted that
§ 105(b) of the Bankruptcy Code specifically prohibits bankruptcy judges
from appointing receivers in a bankruptcy case.
Pursuant to 11 U.S.C. § 543, a trustee or debtor-in-possession may request
that the previously appointed state-court receiver deliver and account for
the rents from the property. Following notice and hearing, the bankruptcy
court, however, may excuse compliance with this section if the interest of
creditors would be better served by permitting the receiver to continue in
possession, custody or control of such property. 11 U.S.C. § 543(d)(1).

If the receiver is an assignee for the benefit of the debtor's creditors that
was appointed or took possession more than 120 days before the date of
the bankruptcy petition, the Bankruptcy Court shall excuse compliance
unless necessary to prevent fraud or injustice. 11 U.S.C. § 543(d)(2).
Subsection (d) reinforces the bankruptcy court's general abstention policy
which is set forth in § 306 of the Bankruptcy Code.

Once a receiver has knowledge of the commencement of a bankruptcy

case, the receiver is prohibited from making disbursements or taking an
action in the administration of the debtor's property, including rents or
profits, except as is necessary to preserve the property. 11 U.S.C. § 543(a).

Thus, court authorization must be obtained by the receiver before he or she

makes any disbursements. If an improper or excessive disbursement is
made, other than in accordance with applicable law or with the approval of
the bankruptcy court, the receiver can be surcharged. 11 U.S.C. § 543(c).
In addition, § 105(a) permits the bankruptcy court to surcharge a receiver
who refuses to turn over property promptly to the trustee and who requests
a hearing under § 543(d) as a dilatory tactic. 4  Collier on Bankruptcy, ¶
543.05 (15th Ed. 1993).

There is some question whether a receiver is entitled to adequate

protection if the receiver is forced to turn over the collateral in its
possession. According to In re Property Management & Investments, Inc.,
17 B.R. 728 (Bankr. N.D. Fla. 1982), a custodian is not entitled to adequate
protection as a condition to turn over. In contrast, the Supreme Court
in  United States v. Whiting Pools, Inc., 462 U.S. 198, 103 S.Ct. 2309, 76
L.Ed.2d 515 (1983), held that an entity that is required to turn over property
of the estate in which it has an interest is entitled to adequate protection of
that interest pursuant to § 542 of the Bankruptcy Code.
Following the rationale in Whiting Pools, some courts have found secured
creditors to be "custodians" within the meaning of §§ 101 and 543 and
have held that such creditors are entitled to adequate protection as a
condition of turn over.  See  In re Brickel, 11 B.R. 353 (Bankr. D. Me.
1981);  Matter of Williams, 6 B.R. 789 (Bankr. E.D. Mich. 1980);  Smitty's,
Inc. v. Southeast National Bank, 1 C.B.C.2d 366 (M.D. Fla. 1979).

H. Use, Sale or Lease of Property.

In a Chapter 11 bankruptcy proceeding, a debtor may use, lease or sell
property under § 363(b) or (c) even though the property may be subject to
a security interest. This authority to use, sell or lease property overrides
any provision in a contract which purports to terminate or modify the
debtor's interest in property, based upon the insolvency or financial
condition of the debtor, the filing of a bankruptcy petition, or the
appointment of a trustee or receiver. 11 U.S.C. § 363(l). Notwithstanding
this authority, § 363 affords the secured creditor some relief by imposing
certain restrictions on the debtor's use, sale or lease of its collateral.

1. Ordinary Course of Business - § 363(c).

Section 363(c) allows the trustee or debtor to use, sell or lease collateral or
other property in which a creditor has an interest in the ordinary course of
business without notice or prior court hearing. There is some restriction on
this broad grant of power. First, the business of the debtor must be
authorized to operate under either § 721, 1108, 1304, 1203 or 1204 of the
Bankruptcy Code. Second, the order permitting the trustee or debtor to
operate the business must not contain any restrictions on this use, sale or
lease of property. Third, §§ 363(a), 1110 and 1168 place certain restrictions
on the use, sale or lease of property with regard to cash collateral, aircraft
equipment and sailing vessels, and rolling stock equipment, respectively.

2. Transactions Other than in the "Ordinary Course of Business."

In order for a trustee or debtor to use, sell or lease property of the estate
other than in the "ordinary course of business," notice and hearing are
required under § 363(b)(1) of the Bankruptcy Code. 3  Collier on
Bankruptcy, ¶ 363.03 (15th ed. 1993), suggests that a court order is not
always required prior to any such use, sale or lease of property. In support
of this argument,  Collier  points to § 102(l) which states that "notice and
hearing" means "after such notice as is appropriate in the particular
circumstances, and such opportunity for a hearing as is appropriate in the
particular circumstances," but authorizes the act without an actual hearing if
one is not timely requested or there is insufficient time for a hearing.

Bankruptcy Rules 2002(a)(2) and 6004(b) govern the applicable notice

provisions. Bankruptcy Rule 2002(a)(2) requires twenty (20) days notice by
mail of a "proposed use, sale or lease of property of the estate other than in
the ordinary course of business unless the court, for cause, shortens the
time or directs another method of giving notice." Note that this rule permits
notice to be sent by first class mail. Parties entitled to notice include those
creditors whose interest will be affected by the sale, the bankruptcy
administrator, the trustee, if one is appointed, the debtor, the creditors'
committee, if appointed, and those creditors who have filed notices of
appearance pursuant to Bankruptcy Rule 2002(a)(2). Where notice by mail
is impracticable, subdivision (k) permits notice by publication.

If the debtor or trustee fails to give notice to a secured party whose lien will
be affected by the subsequent sale or lease of property, the entity which
purchases or leases such property takes the property subject to the lien.

Bankruptcy Rule 6004(b) permits the adoption of a general notice where all
of the non-exempt property of the estate has an aggregate gross value less
than $2,500. In this manner, the trustee or debtor can use, sell or lease
property outside the "ordinary course of business" without the requisite
court approval for each transaction.

If a secured creditor receives notice that the trustee or debtor intends to

use, sell or lease its collateral, Bankruptcy Rule 6004(b) directs the secured
creditor to file and serve its objection upon the moving party at least five (5)
days prior to the date set for the hearing or within the time fixed by the
court. Any objection to the proposed use, sale or lease of property is
treated as a contested matter and governed by Bankruptcy Rule 9014.

All sales not in the ordinary course of business may be by either private
sale or by public auction. Bankruptcy Rule 6004(f)(1) states that unless it is
impracticable, an itemized statement of the property sold, the name of each
purchaser, and the price received for each item or for the property as a
whole if sold in bulk shall be filed on completion of the sale. This report can
be filed by the trustee, the debtor or the auctioneer, if one is appointed.

3. Sale of Collateral Free and Clear of Liens.

The debtor or trustee may sell property free and clear of any liens only if -
(i) applicable non-bankruptcy law permits sale of such property free and
clear of such interests;
(ii) such entity consents;
(iii) such interest is a lien and a price at which such property is to be sold is
greater than the aggravate value of all liens on such property;
(iv) such interest is bona fide dispute; or
(v) such entity could be compelled, in a legal or equitable proceeding, to
accept a money satisfaction of such interest.
11 U.S.C. § 363(f).

At a sale of property that is subject to a lien, the secured creditor, unless

the court orders otherwise, may bid at such sale and, if successful in
purchasing the property, may offset its claim against the purchase price of
such property. 11 U.S.C. § 363(k).

A secured creditor should always require as part of the order authorizing

the property to be sold that its lien be transferred to the proceeds of sale
and that the proceeds be distributed at sale unless otherwise ordered by
the court.

Section 506(c) allows a trustee or debtor to deduct "reasonable, necessary

costs and expenses" for selling the property as a cost of administration
prior to turning over the proceeds to the secured creditor. However, in C.I.T.
Corp. v. A&A Printing, Inc., 70 B.R. 878 (M.D.N.C. 1987), the court found
that this provision did not permit the trustee to charge the secured creditor
with any portion of the rent or security expenses incurred by the estate.

What constitutes "reasonable, necessary costs and expenses" under §

506(c) is fact specific.  See  Matter of Trim-X, Inc., 695 F.2d 296 (7th Cir.
1982). Costs, which are not clearly related to preservation or disposition of
collateral, require additional examination before they can be charged
against the sales proceeds. This examination includes the purpose for
which the costs and expenses were incurred; who derived the benefit; and
the extent of the benefit. Generally, appraisal fees, auctioneer fees,
advertising costs, moving expenses, storage changes, maintenance and
repair costs and marketing costs are allowed, while administrative costs,
overhead, trustee commissions and attorneys' fees are not.

4. Adequate Protection.
At the request of a creditor who has an interest in property to be used, sold
or leased by the trustee or debtor, the court may prohibit or condition such
use, sale or lease as is necessary to provide adequate protection to the
secured creditor of its interest. The bankruptcy trustee or debtor-in-
possession has the burden of proof on the issue of adequate protection
and the secured creditor who has asserted a lien on the property to be sold
has the burden of proof on the validity, priority or extent of the lien. 11
U.S.C. § 363(o).

5. Appeal.
Unless a creditor obtains a stay pending an appeal under Bankruptcy Rule
8005, the reversal or modification on appeal of an authorization under §
363(b) or (c) does not affect the validity of the use, sale or lease under
such authorization. 11 U.S.C. § 363(n). Thus, an entity who leases or
purchases such property in good faith would not be affected by the reversal
or modification, even if that entity had knowledge of the appeal.

FOOTNOTES
1. Section 105(a) of the Bankruptcy Code provides that "[t]he Bankruptcy Court may
issue any order, process, or judgment that is necessary or appropriate to carry out the
provisions of this title." 11 U.S.C. § 105(a). This provision has been relied upon to
effectively continue a stay which has terminated under § 362(d) or for failure to enter an
order within thirty (30) days after the request for relief. In re Walker, 3 B.R. 213 (W. D.
Va. 1980). It has also been used to extend the automatic stay to non-debtor third
parties. See A.H. Robins Co. V. Piccinin, 788 F.2d 994 (4th Cir.), cert. denied, 479 U.S.
876 (1986); In re Kanawha Trace Dev. Partners, 87 B.R. 892 (Bankr. E.D. Va. 1988).
2. 28 U.S.C. § 1481 provides that "[a] Bankruptcy Court shall have the powers of a court
of equity, law, and admiralty, but may not enjoin another court or punish a criminal
contempt not committed in the presence of the judge of the court or warranting a
punishment of imprisonment."
3. 28 U.S.C. §1651 provides, in pertinent part, that "[t]he Supreme Court and all Courts
established by an Act of Congress may issue all writs necessary or appropriate in aid of
their respective jurisdictions and agreeable to the usages and principles of law."
4. Effective October 1, 1993, new N.C. Gen. Stat. § 45-21-22 provides that when a
Debtor files bankruptcy after the Clerk's order authorizing a foreclosure sale and before
the ten (10) day upset bid period has passed, and the stay is thereafter lifted, the
trustee is not required to initiate a new hearing, but most advertise and hold the sale in
accordance with the original order and the provisions of Chapter 305.
5. Section 549(c) of the Bankruptcy Code contains an important limitation on this
principal by protecting good faith purchasers of real property and purchasers at a
judicial sale of real property located in a county other than the one in which the case
was commenced, unless a copy of the petition was filed in the office in such county in
which conveyances of real property are recorded.
6. A preliminary hearing typically differs from a final hearing in that no evidence is
presented. Instead, the court hears declarations of counsel who summarize the
evidence and applicable law. A party may, however, request that the preliminary hearing
be a full evidentiary hearing at which time evidence and testimony will be presented to
the court. If there is a "reasonable likelihood" that the party opposing the relief from stay
will prevail at the final hearing, the court will order that the stay be continued. The
Bankruptcy Code requires that a final hearing be commenced no later than thirty (30)
days at the conclusion of a preliminary hearing. 11 U.S.C. § 362(e).
7. The 4th Circuit in Caroline Corp. v. Miller (In the Matter of Caroline Corp.), 886 F.2d
693 (4th Cir. 1989), has set forth the following two-prong test for determining whether a
petition is filed in bad faith:
Upon consideration, we agree with those courts that require that  both  objective utility
and subjective bad faith be shown in order to warrant dismissal for one of good faith in
filing. This means that if the only question raised is whether a reorganization is
realistically possible, i.e., if there is no question of the petitioner's subjective good faith
in filing, threshold dismissal of a petition is not warranted. In those circumstances, the
question of ultimate futility is better left to post-petition developments. By the same
token, even if subjective bad faith in filing could properly be found, dismissal is not
warranted if futility could not be found.
8. In order to qualify under § 1322(b)(2), the residence must constitute real property. 11
U.S.C. § 1322(b)(2). A mobile home, for example, may not constitute real property
under applicable non-bankruptcy law and, therefore, the rights of the secured creditor
can be modified and the lien stripped down.  In re Thurston, 73 B.R. 138 (Bankr. N.D.
Tex. 1987).
9. A class of claims is deemed to have accepted a plan if the creditors holding at least
two-thirds an amount and more than one-half the number of the allowed claims of such
class have voted to accept the plan. 11 U.S.C. § 1126(c). Remember that the debtor
must have at least one "impaired" class voting to accept its plan; otherwise, it cannot be
confirmed under § 1129. 11 U.S.C. § 1129(a)(10).
10. N.C. Gen. Stat. § 39-15 provides for a three-year statute of limitations on fraudulent
conveyance actions while the comparable bankruptcy statute § 548 has only a one-year
reach back.
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